SECURITIES AND EXCHANGE COMMISSION

                             WASHINGTON, D.C. 20549

                                    FORM 10-Q


              [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended June 30, 1998

                                       OR

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                        For the transition period from to

                           Commission File No.: 1-5270

                              SOFTNET SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

              New York                                 11-1817252
   --------------------------------        ---------------------------------
   (State or other jurisdiction of        (I.R.S. Employer Identification No.)
     incorporation or organization)

   520 Logue Avenue, Mountain View, California               94043
   -------------------------------------------          --------------
   (Address of principal executive offices)              (Zip Code)

Registrant's telephone number, including area code:  (650) 965-3700

                                 Not Applicable
--------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days.

                                    Yes X    No
                                       ---     ---

Indicate the number of shares  outstanding  of each of the  issuer's  classes of
common stock, as of the latest practicable date.

              Class                            Outstanding at July 31, 1998
  -------------------------------             --------------------------------
         Common stock, par                                8,157,756
       value $.01 per share                     

<PAGE> 


                              SOFTNET SYSTEMS, INC.

                                      INDEX




PART I        FINANCIAL INFORMATION

     Item 1.  Financial Statements (Unaudited)

              Condensed  Consolidated  Balance  Sheets  as of June 30,  1998 and
              September 30, 1997

              Condensed  Consolidated  Statements  of  Operations  for the Three
              Months and Nine Months Ended June 30, 1998 and 1997

              Condensed  Consolidated  Statements  of Cash  Flows  for the  Nine
              Months Ended June 30, 1998 and 1997

              Notes to Condensed Consolidated Financial Statements

     Item 2.  Management's  Discussion and  Analysis of  Financial Condition and
              Results of Operations


PART II       OTHER INFORMATION

     Item 2.  Changes in Securities

     Item 5.  Other Information

     Item 6.  Exhibits and Reports on Form 8-K


<PAGE>

                     SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
                      Condensed Consolidated Balance Sheets
                   As of June 30, 1998 and September 30, 1997
                        (In thousands, except share data)



                                                         June 30,  September 30,
                                                           1998        1997
                                                         --------    --------
                                                       (Unaudited)
       ASSETS

Current assets:
   Cash                                                  $  9,818    $     37
   Accounts receivables, net                                5,459       5,135
   Inventories                                              1,930       1,326
   Prepaid expenses                                           411         319
                                                         --------    --------
       Total current assets                                17,618       6,817

Property and equipment, net                                 2,912       1,108
Costs in excess of fair value 
   of net assets acquired, net                              4,327       5,141
Other assets                                                3,730       3,820
Net assets associated with discontinued operations          4,143       3,435
                                                         --------    --------
                                                         $ 32,730    $ 20,321
                                                         ========    ========

       LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
   Accounts payable and accrued expenses                 $  6,580    $  4,969
   Current portion of long term debt                        1,577       1,384
   Current portion of capital leases                          157          23
   Deferred revenue                                           343         143
                                                         --------    --------
       Total current liabilities                            8,657       6,519
                                                         --------    --------

Long term debt, net of current portion                     10,757      11,727
                                                         --------    --------

Capital lease obligation, net of current portion              149          47
                                                         --------    --------

Shareholders' equity:
   Preferred stock, $.10 par value, 
       4 million shares authorized,
          Series A Convertible, 3,062.5 shares 
            outstanding at June 30, 1998                     --          --
          Series B Convertible, 10,000 shares 
            outstanding at June 30, 1998                        1        --
   Common stock, $.01 par value, 
       25 million shares authorized,
       7,869,647 and 6,870,559 shares 
       outstanding, respectively                               79          69
   Capital in excess of par value                          52,303      34,379
   Accumulated deficit                                    (39,216)    (32,420)
                                                         --------    --------
       Total shareholders' equity                          13,167       2,028
                                                         --------    --------
                                                         $ 32,730    $ 20,321
                                                         ========    ========





The  accompanying  notes are an integral  part of these  condensed  consolidated
financial statements.






                                       3
<PAGE>


                     SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
                 Condensed Consolidated Statements of Operations
                      For the Three Months and Nine Months
                        Ended June 30, 1998 and 1997 (In
                        thousands, except per share data)
                                   (Unaudited)


<TABLE>
<CAPTION>

                                                      Three Months Ended      Nine Months Ended
                                                           June 30,               June 30,
                                                     --------------------    --------------------
                                                       1998        1997        1998        1997
                                                     --------    --------    --------    --------
<S>                                                  <C>         <C>         <C>         <C>     
Net sales                                            $  3,615    $  5,490    $ 10,844    $ 16,825
Cost of sales                                           2,751       2,935       8,003       9,239
                                                     --------    --------    --------    --------
   Gross profit                                           864       2,555       2,841       7,586
                                                     --------    --------    --------    --------

Operating expenses:
   Selling                                              1,193         404       2,297       1,383
   Engineering                                            547         576       1,772       1,691
   General and administrative                           1,834         959       4,119       2,673
   Amortization of goodwill and transaction costs         322         322         965         965
                                                     --------    --------    --------    --------
       Total operating expenses                         3,896       2,261       9,153       6,712
                                                     --------    --------    --------    --------

   Income (loss) from continuing operations            (3,032)        294      (6,312)        874

Interest expense                                         (319)       (272)       (915)       (826)
Other income (expense)                                     41         (83)        211           3
                                                     --------    --------    --------    --------

   Income (loss) from continuing operations before
       income taxes                                    (3,310)        (61)     (7,016)         51

Provision for income taxes                               --          --          --          --
                                                     --------    --------    --------    --------

   Income (loss) before discontinued operations        (3,310)        (61)     (7,016)         51

Discontinued operations
   Income (loss) from operations                          253         (67)        368         360
                                                     --------    --------    --------    --------

Net income (loss)                                    $ (3,057)   $   (128)   $ (6,648)   $    411
                                                     ========    ========    ========    ========

Preferred dividends                                       (85)       --          (148)       --
                                                     --------    --------    --------    --------

Net income (loss) applicable to common shares        $ (3,142)   $   (128)   $ (6,796)   $    411
                                                     ========    ========    ========    ========

Basic and diluted earnings (loss) per common share:

   For continuing operations                         $  (0.45)   $  (0.01)   $  (1.00)   $   0.01
                                                     ========    ========    ========    ========
   For discontinued operations                       $   0.03    $  (0.01)   $   0.05    $   0.05
                                                     ========    ========    ========    ========
   Net income (loss) applicable
       to common shares                              $  (0.42)   $  (0.02)   $  (0.95)   $   0.06
                                                     ========    ========    ========    ========

</TABLE>






The  accompanying  notes are an integral  part of these  condensed  consolidated
financial statements.



                                       4
<PAGE>
                     SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
                 Condensed Consolidated Statements of Cash Flows
                For the Nine Months Ended June 30, 1998 and 1997
                                 (In thousands)
                                   (Unaudited)


                                                               1998        1997
                                                           --------    --------
Cash flows from operating activities:
   Net income (loss)                                       $ (6,648)   $    411
     Adjustments to reconcile net income (loss)
       to net cash used in
       operating activities:
         Income from discontinued operations                    368         360
         Depreciation and amortization                        1,504       1,315
         Provision for bad debts                                190        --
         Gain on disposition of net assets                     --           (77)
     Changes in operating assets and liabilities:
       Receivables                                              589      (2,224)
       Inventories                                             (285)      1,108
       Prepaid expenses                                         (27)        155
       Accounts payable and accrued expenses                  1,896         411
       Deferred revenue                                         200          94
                                                           --------    --------
Net cash provided by (used in)operating activities
       of continuing operations                              (2,213)      1,553
                                                           --------    --------
Net cash used in operating activities
       of discontinued operations                            (1,036)     (1,112)
                                                           --------    --------

Cash flows from investing activities:
   Purchase of property and equipment                        (2,028)       (174)
   Additions to capitalized product design                     --          (610)
   Other                                                        (90)       --
                                                           --------    --------
Net cash used in investing activities
    of continuing operations                                 (2,118)       (784)
                                                           --------    --------
Net cash used in investing activities 
    of discontinued operations                                  (72)        (62)
                                                           --------    --------

Cash flows from financing activities:
   Repayment of long-term debt                               (1,086)        (76)
   Borrowings under revolving credit note                     8,647       7,973
   Payments under revolving credit note                      (9,111)     (8,284)
   Proceeds from issuance of long-term debt                     359         737
   Proceeds from sale of preferred stock                     14,100        --
   Proceeds from exercise of warrants and options             2,721        --
   Capitalized lease obligations paid                           (91)        (88)
                                                           --------    --------
Net cash provided by financing activities
    of continuing operations                                 15,539         262
                                                           --------    --------
Net cash used in financing activities 
    of discontinued operations                                 (319)       (268)
                                                           --------    --------

Increase (decrease) in cash                                   9,781        (411)
Cash, beginning of period                                        37         426
                                                           --------    --------
Cash, end of period                                        $  9,818    $     15
                                                           ========    ========

Cash paid during the period for:
    Interest                                               $  1,029    $    744
    Income taxes                                               --          --

Supplemental non-cash transactions
    Convertible debt issued for 
       acquisition of equipment leases                     $  1,444    $   --
    Common stock issued for the conversion
       of subordinated notes                                  1,046         381
    Note received in sale of net assets                         110        --
    Equipment acquired by capital lease                         326        --

The  accompanying  notes are an integral  part of these  condensed  consolidated
financial statements.
                                    5
<PAGE>


                     SOFTNET SYSTEMS, INC. AND SUBSIDIARIES
              Notes to Condensed Consolidated Financial Statements



1.   Basis of Presentation

     The financial information,  except for the consolidated balance sheet as of
September 30, 1997,  included  herein is unaudited;  however,  such  information
reflects all adjustments  (consisting  solely of normal  recurring  adjustments)
which are, in the opinion of management,  necessary for a fair  presentation  of
the  condensed  consolidated  statements  of  financial  position,   results  of
operations and cash flows as of and for the interim  periods ended June 30, 1998
and 1997.

     The  Company's  annual  report  on Form  10-K  for the  fiscal  year  ended
September 30, 1997, as filed with the Securities and Exchange Commission, should
be read in conjunction with the accompanying  condensed  consolidated  financial
statements.  The condensed  consolidated  balance sheet as of September 30, 1997
was derived from the Company's audited Consolidated Financial Statements.

     The results of  operations  for the three months and nine months ended June
30,  1998  are  based  in part on  estimates  that may be  subject  to  year-end
adjustments and are not necessarily indicative of the results to be expected for
the full year.

2.   Debt

     Long-term debt is summarized as follows (in thousands):
                                               June 30,        September 30,
                                                 1998               1997

     Bank Debt (See Note 3)                  $     7,971      $     8,973
     Convertible subordinated notes                4,022            3,624
     Other                                           341              514
                                              ----------       ----------
                                                  12,334           13,111
     Less current portion                         (1,577)          (1,384)
                                               ---------        ---------
                                              $   10,757       $   11,727
                                              ==========       ==========


     On January 2, 1998, the Company issued  $1,443,750  principal amount of its
5%  Convertible  Subordinated  Debentures  due  September  30,  2002 to a single
investor  in exchange  for the  assignment  to the Company of certain  equipment
leases and other consideration. The debentures are convertible into Common Stock
of the Company, at $8.25 per share, after December 31, 1998.

     On April 20,  1998,  the  Company  issued  120,000  shares of Common  Stock
pursuant to the conversion of $810,000 of convertible debt by a single holder of
the Company's 9% convertible subordinated notes due September 15, 2000. These 9%
notes have a conversion price of $6.75 per share.

3.   Preferred Stock

     On December 31, 1997, the Company sold 5,000 shares of Series A Convertible
Preferred Stock,  $0.10 par value per share ("Series A Convertible  Preferred"),
for an  aggregate  purchase  price  of $5  million.  The  Series  A  Convertible
Preferred accrues dividends at a rate of 5% per annum, payable quarterly, at the
Company's  option,  in  cash  or  additional  shares  of  Series  A  Convertible
Preferred.  In addition,  the Company issued warrants to purchase 170,000 shares
of the  Company's  Common Stock at prices at or above the market  price  (20,000
shares at $6.625  expiring  on December  31,  2000 and  150,000  shares at $7.95
expiring on December  31,  2001).  On January 2, 1998,  the Company used the net
proceeds  of $4.6  million,  after  issuance  costs of  $400,000,  to reduce the
balance of the bank revolving credit note.



<PAGE>




     Each share of Series A Convertible Preferred is convertible,  at the option
of the  holder,  into the  number of shares of  Common  Stock as  determined  by
multiplying  the stated  value of the Series A  Convertible  Preferred by 5% per
annum,  subtracting  any dividends  paid,  and dividing  such  difference by the
conversion  price.  The stated  value of the Series A  Convertible  Preferred is
$1,000  per  share and the  conversion  price is the lower of $8.28 or a two day
average  market  price within a 20 day trading  period prior to the  conversion.
Pursuant to the Company's Articles of Incorporation,  as amended, the holders of
the Series A Convertible  Preferred may only convert their outstanding shares of
Series A  Convertible  Preferred  into an aggregate  amount of Common Stock that
does not exceed  19.99% of the  outstanding  Common  Stock of the  Company.  Any
excess shares of Common Stock that are issuable upon  conversion of  outstanding
Series A Convertible Preferred that exceed this 19.99% limitation are subject to
mandatory  redemption  at the option of the  holder of the Series A  Convertible
Preferred,  unless the  Company  either  obtains  stockholder  approval  for the
additional  conversions,  or the Company  receives  permission  to allow such an
issuance from the American Stock Exchange.  All  outstanding  shares of Series A
Convertible Preferred, subject to the aforementioned restrictions, automatically
convert to Common Stock on December 31, 2000.

     Holders of Series A Convertible Preferred do not have voting rights, except
for certain protective  provisions  relating to changes in the rights of holders
of Series A  Convertible  Preferred.  The Series A Convertible  Preferred  ranks
senior  to  the  Company's  Common  Stock  as to  dividends,  distributions  and
distribution  of assets  upon  liquidation,  dissolution  or  winding  up of the
Company.  The Series A Convertible  Preferred is subject to mandatory redemption
upon certain  circumstances,  including the Company's (i) failure to convert the
Series  A  Convertible  Preferred  when  required  (ii)  bankruptcy,  and  (iii)
suspension of the Common Stock from trading on the American Stock Exchange.  The
Company shall have the right to redeem the Series A Convertible  Preferred on or
after  December  31,  1998 at a price equal to the greater of 130% of the stated
value or the market  price  multiplied  by the number of shares of Common  Stock
into which the Series A Convertible Preferred can be converted.

     On March 31, 1998, the Company issued an additional 62.5 shares of Series A
Convertible  Preferred  as  payment  for  $62,500  of  earned  dividends  on the
outstanding shares of Series A Convertible Preferred.

     During the quarter ended June 30, 1998, the Company issued a combined total
of 299,946 shares of Common Stock, pursuant to the conversion of 2,000 shares of
the  Company's  outstanding  Series  A  Convertible  Preferred.   The  Series  A
Convertible  Preferred,  including accrued dividends,  was converted into common
shares at the conversion price of $6.69 per share.

     On May 28, 1998,  the Company  issued 10,000 shares of Series B Convertible
Preferred Stock,  $0.10 par value per share ("Series B Convertible  Preferred"),
for an  aggregate  purchase  price of $10  million.  The  Series  B  Convertible
Preferred accrues dividends at a rate of 5% per annum, payable quarterly, at the
Company's  option,  in  cash  or  additional  shares  of  Series  B  Convertible
Preferred.  In addition,  the Company issued warrants to purchase 200,000 shares
of the Company's  Common Stock at $13.75 and warrants to purchase  50,000 shares
of the Company's Common Stock at $11.00, all of which expire on May 28, 2002.

     Each share of Series B Convertible Preferred is convertible,  at the option
of the  holder,  into the  number of shares of  common  stock as  determined  by
multiplying  the stated  value of the Series B  Convertible  Preferred by 5% per
annum,  subtracting  any dividends  paid,  and dividing  such  difference by the
conversion  price.  The stated  value of the Series B  Convertible  Preferred is
$1,000 per share.  Prior to the ninth month  anniversary  of the issuance of the
Series B Convertible Preferred,  the conversion price is $13.20. After the ninth
month  anniversary,  the conversion  price is the lower of $13.20 (subject to an
escalation  provision  pending  certain market  conditions  surrounding the nine
month  anniversary)  or a five day average  market price within a 20-day trading
period  prior  to the  conversion.  Pursuant  to the  Company's  Certificate  of
Incorporation, as amended, the holders of the Series B Convertible Preferred may
only convert their outstanding shares of Series B Convertible  Preferred into an
aggregate  amount of Common Stock that does not exceed 19.99% of the outstanding
Common Stock of the Company. Any excess shares of Common Stock that are issuable
upon conversion of outstanding  Series B Convertible  Preferred that exceed this
19.99%  limitation  are  subject to  mandatory  redemption  at the option of the
holder of the Series B Convertible Preferred,  unless the Company either obtains
shareholder  approval for the additional  conversions,  or the Company  receives
permission  to allow  such  issuances  from the  American  Stock  Exchange.  All
outstanding   shares  of  Series  B  Convertible   Preferred,   subject  to  the
aforementioned  restrictions,  automatically  convert to Common Stock on May 28,
2001.

         Holders of Series B  Convertible  Preferred do not have voting  rights,
except for certain  protective  provisions  relating to changes in the rights of
holders of Series B Convertible  Preferred.  The Series B Convertible  Preferred
ranks senior to the  Company's  Common  Stock,  and pari passu with the Series A
Convertible Preferred, as to dividends, distributions and distribution of assets
upon  liquidation,  dissolution  or  winding  up of the  Company.  The  Series B
Convertible  Preferred  is subject to  redemption  upon  certain  circumstances,
including  the  Company's  (i)  failure  to  convert  the  Series B  Convertible
Preferred when required (ii) failure to fulfill  obligations  under that certain
Registration  Rights  Agreement  among the  Company  and holders of the Series B
Convertible Preferred,  and (iii) suspension of the Common Stock from trading on
the  American  Stock  Exchange.  The Company  shall have the right to redeem the
Series B Convertible Preferred on or after November 28, 1998 at a price equal to
the greater of 120% of the stated  value or the market price  multiplied  by the
number of shares of Common Stock into which the Series B  Convertible  Preferred
can be converted.


4.   Stock Options and Warrants

     Outstanding options and warrants to purchase shares of Common Stock at June
30, 1998 were as follows (in thousands, except price per option data):

         Outstanding at September 30, 1997                        1,435
              Granted at exercise prices ranging 
                from $4.85 to $13.75 per share                    1,510
              Canceled                                              (61)
              Exercised at exercise prices ranging
                from $1.75 to $8.25 per share                      (556)
         Outstanding at June 30, 1998                             2,328
                                                                =======


5.   Earnings (Loss) per Share

     The Company adopted Statement of Financial  Accounting  Standard (SFAS) No.
128,  "Earnings  Per Share," in the quarter  ended  December 31, 1997.  SFAS 128
requires the computation of basic and diluted earnings per share. Basic earnings
(loss) per common share is computed using the weighted  average number of common
shares  outstanding.  Diluted earnings (loss) per common share is computed using
the weighted average number of common shares outstanding and the dilutive common
stock  equivalents  (using the treasury  stock method for warrants and options).
The computation of earnings (loss) per share for continuing  operations includes
the effect of preferred  dividends.  Summarized below is the  reconciliation  of
basic and diluted  earnings (loss) per common share for the three months and the
nine months ended June 30, 1998 and 1997 (in  thousands  except per common share
amounts):
<TABLE>
<CAPTION>

                                                For the Three Months Ended            For the Nine Months Ended
                                                --------------------------          -----------------------------
                                               Net Income         Per Share          Net Income           Per Share
                                                 (Loss)   Shares    Amount             (Loss)     Shares   Amount
                                                 ------   ------    ------             ------     ------   ------
<S>                                            <C>         <C>      <C>              <C>           <C>     <C>    
June 30, 1998:
   Basic loss                                  $ (3,142)   7,502    $(0.42)          $ (6,796)     7,144   $(0.95)
     Effect of outstanding securities (a) -
       Warrants and options                          -        -                            -          -      
       Convertible debt                              -        -                            -          -      
       Convertible preferred stock                   -        -                            -          -     
                                               --------    -----                     --------      ----- 
   Diluted loss                                $ (3,142)   7,502    $(0.42)          $ (6,796)     7,144   $(0.95)
                                               --------    -----                     --------      -----

June 30, 1997:
   Basic earnings (loss)                      $    (128)   6,592    $(0.02)         $     411      6,575   $ 0.06
     Effect of outstanding securities (b) -
       Warrants and options                          -        -                            -         319      
       Convertible debt                              -        -                            -          -      
       Convertible preferred stock                   -        -                            -          -      
                                               --------    -----                     --------      -----     
   Diluted earnings (loss)                    $    (128)   6,592    $(0.02)          $    411      6,894   $ 0.06
                                               --------    -----                     --------      -----

<FN>
     (a)  As  the  Company  had a net  loss,  the  outstanding  securities  were
          antidilutive. 

     (b)  The remaining outstanding securities were antidilutive.
</FN>
</TABLE>
<PAGE>



6.   Subsequent Event

     On July 3, 1998, the Company pledged  $800,000 as collateral on a Letter of
Credit  relating to certain leased office space.  This amount will be classified
as restricted cash in subsequent balance sheet presentations.

     On July 27, 1998, the Board of Directors of the Company  approved a plan to
offer for sale its telecommunications  segment.  Accordingly,  operating results
have been reclassified and reported in discontinued  operations.  The Company is
in the process of negotiating the sale of these  operations and expects that the
sale  will be  completed  within  a twelve  month  period.  Management  does not
anticipate  a loss on the  sale  and  intends  to use sale  proceeds  to  reduce
outstanding indebtedness and provide additional working capital.

     Operating results of discontinued telecommunications segment are as follows
(in thousands):

                    
                            Three Months Ended             Nine Months Ended
                                 June 30,                       June 30,
                            1998           1997           1998            1997
                         --------       --------        --------       --------
  Revenues               $  4,425       $  3,631        $ 12,817       $ 13,248
  Net income (loss)      $    253       $    (67)       $    368       $    360


     Assets and liabilities of the discontinued  telecommunications  segment are
as follows:
                                                  
                                                   June 30,       Sept. 30,
                                                     1998           1997
                                                  ---------       ---------
   Current assets:
     Cash                                         $       -      $        -
     Accounts receivable, net                         2,455           1,848
     Inventories                                      2,197           2,984
     Prepaid expenses                                   143             154
                                                  ---------       ---------
                                                      4,795           4,986
                                                  ---------       ---------

     Property, plant and equipment, net                 402             529
     Goodwill, net                                    1,687           1,759
     Other noncurrent assets                            132             217
                                                  ---------       ---------
                                                  $   7,016       $   7,491
                                                  =========       =========


   Current liabilities:
     Accounts payable                             $   2,184       $   2,295
     Current portion, long term debt                     31             328
     Current portion, capital
       lease obligation                                  23              23
     Deferred revenue                                   600           1,336
                                                  ---------       ---------
                                                      2,838           3,982
                                                  ---------       ---------

   Long-term debt, net of current portion                 -              20
   Capital lease obligation, 
       net of current portion                            35              54
                                                  ---------       ---------
                                                  $   2,873       $   4,056
                                                  =========       =========

   Net assets associated with 
       discontinued operations                    $   4,143       $   3,435
                                                  =========       =========

     The  financial  statements  have  been  restated  for  the  effects  of the
discontinued operations of the telecommunications segment.







Item 2.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations

General

This  Form 10-Q  contains  forward-looking  statements  that  involve  risks and
uncertainties.  The actual results of SoftNet Systems, Inc. and its subsidiaries
could differ significantly from those set forth herein. Factors that could cause
or  contribute  to such  differences  include,  but are not  limited  to,  those
discussed in "Risk Factors" as set forth in the Company's Current Report on Form
8-K filed with the  Securities  and Exchange  Commission  on July 28, 1998,  and
"Management's  Discussion  and  Analysis of Financial  Condition  and Results of
Operations"  as well as those  discussed  elsewhere  in this  Quarterly  Report.
Statements  contained herein that are not historical  facts are  forward-looking
statements that are subject to the safe harbor created by the Private Securities
Litigation  Reform  Act  of  1995.  Words  such  as  "believes",  "anticipates",
"expects",   "intends"  and  similar   expressions   are  intended  to  identify
forward-looking  statements, but are not the exclusive means of identifying such
statements.  A number of  important  factors  could cause the  Company's  actual
results for fiscal 1998 and beyond to differ  materially  from past  results and
those expressed in any forward-looking  statements made by, or on behalf of, the
Company.  These factors  include,  without  limitation,  the following:  limited
operating  history;  lack of profitable  operations;  fluctuations  in quarterly
results;  lack  of  backlog;  rapid  technological  change;  dependence  on  new
products;  dependence on the Internet;  ability to expand the Internet business;
risks associated with acquisitions;  and competition.  The Company undertakes no
obligation   to  release   publicly  the  results  of  any  revisions  to  these
forward-looking  statements that may be made to reflect events or  circumstances
after the date hereof or to reflect the occurrence of unanticipated events.

The Company's  fiscal year ends September 30 and the third quarter of the fiscal
year ends June 30.  "Fiscal 1998" refers to the twelve  months ending  September
30, 1998 with similar  references to other twelve month periods ending September
30.

Results of  operations  for the Third  Quarter of Fiscal 1998 as compared to the
same period in Fiscal 1997

Consolidated  net sales  decreased  $1.9 million (or 34.2%) for the three months
ended  June 30,  1998,  as  compared  to the same  period in 1997.  Sales in the
document  management  segment  decreased $2.1 million (or 39.1%), as compared to
the same  period in 1997,  primarily  as a result of a  decrease  in the sale of
computer output microfiche  equipment ("COM") and associated spare parts.  Sales
in the Internet segment  increased  $194,000 (or 99.5%), as compared to the same
period in 1997,  primarily due to an increase in sales for the  segment's  cable
services.  The Company formally introduced these cable services to the market in
the third quarter of fiscal 1997.

Consolidated  gross profit decreased $1.7 million in the three months ended June
30, 1998, with profit margins decreasing to 23.9% from 46.5% for the same period
in 1997.  The  percentage  decrease is primarily  related to the decrease in the
document  management   segment's  COM  sales  Profit  margins  in  the  document
management  segment  decreased for the three months ended June 30, 1998 to 33.5%
from 49.0% for the same period in 1997. Gross profit  decreased  $214,000 in the
Internet segment for the three months ended June 30, 1998, primarily as a result
of the expansion of the segment's technical and customer support  infrastructure
related to the  segment's  cable  service  offering.  In  addition,  certain web
development expenses have been reclassed entirely to cost of goods sold. Similar
web development expenses in prior year presentations have not been reclassified,
due to immateriality.

Operating expenses (selling, engineering,  general and administrative) increased
$1.6  million to $3.6 million for the three months ended June 30, 1998 from $2.0
million  for the same period in 1997.  The  increase  in  operating  expenses is
primarily the result of an increase in the  administrative,  sales and marketing
efforts of the Company's  Internet  segment  associated with the segment's cable
service  offering.  Operating  expenses  increased $1.3 million for the Internet
segment for the three months ended June 30, 1998, as compared to the same period
in 1997.

Consolidated  interest expense  increased $47,000 (or 17.2%) to $319,000 for the
three  months ended June 30, 1998 as compared to $272,000 for the same period in
1997. Other income increased $124,000 to $41,000 for the three months ended June
30, 1998, as compared to an expense of $83,000 for the same period in 1997. This
increase  is  primarily  the  result of the  interest  income  generated  by the
document management segment's price per fiche, customer leasing alternative.

The Company made no  provision  for income taxes for the three months ended June
30, 1998, as a result of the Company's net operating loss carry-forward.

The Company  recognized  income from operations with respect to its discontinued
telecommunications segment of $253,000 for the three months ended June 30, 1998,
as compared to a loss from operations of $67,000 for the same period in 1997.

For the third quarter of fiscal 1998,  the Company had a net loss  applicable to
common  shares of $3.1  million,  or a basic loss per common share of $0.42,  as
compared to a net loss of  $128,000,  or a basic loss per common  share of $0.02
for the same period in fiscal 1997.

Results of  operations  for the first Nine  Months of Fiscal 1998 as compared to
the same period in Fiscal 1997

Consolidated  net sales  decreased  $6.0  million (or 35.6%) for the nine months
ended  June 30,  1998,  as  compared  to the same  period in 1997.  Sales in the
document  management  segment decreased $6.1 million (or 38.4%),  primarily as a
result of a decrease in COM sales. COM sales decreased $4.0 million for the nine
months ended June 30, 1998, as compared to the same period in 1997. Decreases in
the  segment's  spare  part  sales and other  ancillary  products  and  services
accounted for the remaining  shortfall.  Sales in the Internet segment increased
$161,000 (or 19.7%) for the nine months ended June 30, 1998,  as compared to the
same period in 1997.  Sales related to the segment's  cable  services  increased
approximately  $350,000 for the nine months ended June 30 , 1998, as compared to
the same  period  in 1997,  offsetting  a  decrease  in the  segment's  one-time
miscellaneous  sales. The Company formally  introduced its cable services to the
market in the third quarter of fiscal 1997. 


Consolidated  gross profit  decreased $4.7 million in the nine months ended June
30, 1998, with profit margins decreasing to 26.2% from 45.1% for the same period
in 1997.  The  percentage  decrease is primarily  related to the decrease in the
document  management   segment's  COM  sales  Profit  margins  in  the  document
management  segment  decreased  for the nine months ended June 30, 1998 to 32.0%
from 46.5% for the same period in 1997. Gross profits  decreased $4.3 million in
the  document  management  segment in the nine months  ended June 30,  1998,  as
compared  to the same period in 1997.  Gross  profit  decreased  $451,000 in the
Internet segment for the nine months ended June 30, 1998,  primarily as a result
of the expansion of the segment's technical and customer support  infrastructure
related to the  segment's  cable  service  offering.  In  addition,  certain web
development expenses have been reclassed entirely to cost of goods sold. Similar
web development expenses in prior year presentations have not been reclassified,
due to immateriality.

Operating expenses (selling, engineering,  general and administrative) increased
$2.4 million to $8.2 million for the nine months ended June 30, 1998,  from $5.8
million  for the same period in 1997.  The  increase  in  operating  expenses is
partially the result of the  consolidation  and  relocation of the Chicago based
operations to the Company's existing headquarters in Mountain View,  California.
These  activities  resulted in the one time write-off of leasehold  improvements
and moving expenses of $240,000.  In addition,  operating  expenses increased in
the  Internet  segment by over $1.9  million for the nine months  ended June 30,
1998,  primarily as the result of an increase in the  segment's  administrative,
sales  and  marketing  efforts  associated  with  the  segment's  cable  service
offering.

Consolidated  interest expense  increased $89,000 (or 10.8%) to $915,000 for the
nine months ended June 30, 1998,  as compared to $826,000 for the same period in
1997. Other income increased $208,000 to $211,000 for the nine months ended June
30, 1998. This increase is primarily the result of the interest income generated
by  the  document  management  segment's  price  per  fiche,   customer  leasing
alternative.

The Company  made no  provision  for income taxes for the nine months ended June
30, 1998, as a result of the Company's net operating loss carry-forward.

The Company  recognized  income from operations with respect to its discontinued
telecommunications  segment of $368,000 for the nine months ended June 30, 1998,
as compared to income from operations of $360,000 for the same period in 1997.

For the first nine months of fiscal 1998, the Company had a net loss  applicable
to  common  shares of $6.8  million,  or a basic  loss per  share of  $0.95,  as
compared to net income of $411,000, or basic earnings per share of $0.06 for the
same period in fiscal 1997.


Liquidity and Capital Resources

At June 30, 1998, the Company's current ratio was 2.04 to 1 with working capital
of $9.0  million.  This  compares  with a current ratio of 1.05 to 1 and working
capital of $298,000 at September 30, 1997.

For the  first  nine  months  of  fiscal  1998,  cash  flows  used in  operating
activities of continuing operations were $2.2 million, as compared to cash flows
provided by operating  activities of  continuing  operations of $1.6 million for
the same period in fiscal  1997.  The  Company  used $2.1  million in  investing
activities of continuing  operations during the first nine months ended June 30,
1998, as compared to $784,000 used in the same period of 1997. This $1.3 million
increase in cash used in investing  activities  is  primarily  the result of the
acquisition  of certain  property and equipment  used by the Company's  Internet
segment to build up the  infrastructure  for its cable  service  offering.  Cash
flows  provided by financing  activities  were $15.5  million for the first nine
months of fiscal  1998,  as compared  to $262,000  for the same period in fiscal
1997.

On December  31, 1997,  the Company  sold 5,000  shares of Series A  Convertible
Preferred  Stock and warrants to purchase  150,000 shares of Common Stock for $5
million.  On January 2, 1998, the net proceeds of this sale of $4.6 million were
used to reduce the balance of the  Company's  revolving  credit note. On May 28,
1998, the Company sold 10,000 shares of Series B Convertible Preferred Stock and
warrants to purchase  200,000 shares of Common Stock for $10 million (See Note 3
of Notes to  Condensed  Consolidated  Financial  Statements).  The  Company  has
extended  the  maturity  of its  revolving  credit  note,  which  has a  maximum
borrowing capacity of $9.5 million, through July 15, 1999.

The Company expects to be able to finance its working capital  requirements  and
capital  expenditures  for its document  management  segment from its  operating
income  and  existing  line-of-credit  facilities  for the  fiscal  year  ending
September  30,  1998.  However,  the  Company  believes  it will  need to  raise
substantial   additional  capital  to  fund  the  Company's   aggregate  capital
expenditures  and working  capital  requirements,  including  operating  losses,
associated with achieving its market penetration  objectives with respect to the
operations of its Internet  segment.  The Company's future cash requirements for
its business plan expansion will depend on a number of factors including (i) the
number of cable affiliate  contracts,  (ii) cable modem and associated  costs of
equipment,  (iii) the rate at which subscribers  purchase the Company's Internet
service offering and (iv) the level of marketing  required to acquire and retain
subscribers  and  to  attain  a  competitive  position  in the  marketplace.  In
addition,  the Company may wish to selectively  pursue possible  acquisitions of
businesses,  technologies,  content or  products  complementary  to those of the
Company in the  future in order to expand  its  Internet  presence  and  achieve
operating  efficiencies.  The  Company  may seek to  obtain  additional  funding
through the sale of public or private debt and/or equity securities or through a
bank credit facility.  There can be no assurance as to the availability or terms
upon which such financing might be available.

Other - Year 2000 Issue

Many existing  computer  systems and related  software  applications,  and other
control devices, use only two digits to identify a year in a date field, without
considering  the impact of the  upcoming  change in the century.  Such  systems,
applications  and/or  devices  could  fail or create  erroneous  results  unless
corrected so that they can process  data  related to the Year 2000.  The Company
relies on such  computer  systems,  applications  and devices in  operating  and
monitoring all major aspects of its business, including, but not limited to, its
financial  systems  (such  as  general  ledger,  accounts  payable  and  payroll
modules), customer services, internal networks and telecommunications equipment,
and end  products.  The Company also relies,  directly  and  indirectly,  on the
external  systems  of  various  independent  business  enterprises,  such as its
customers,  suppliers,  creditors, financial organizations,  and of governments,
both  domestically and  internationally,  for the accurate  exchange of data and
related information.

The Company is currently in the process of evaluating  the  potential  impact of
the Year 2000 issue on its business and the related  expenses  that could likely
be  incurred  in  attempting  to  remedy  such  impact  (including  testing  and
implementation  of remedial action).  Management's  current estimate is that the
costs  associated  with the Year 2000 issue  should not have a material  adverse
affect on the results of operations or financial  position of the Company in any
given  year.  However,  despite the  Company's  efforts to address the Year 2000
impact  on its  internal  systems,  the  Company  is not sure  that it has fully
identified  such  impact or that it can  resolve  it without  disruption  of its
business and without incurring significant  expenses.  In addition,  even if the
internal  systems of the  Company are not  materially  affected by the Year 2000
issue,  the  Company  could be  affected  as a result of any  disruption  in the
operation  of  the  various  third-party  enterprises  with  which  the  Company
interacts, such as cable affiliates, vendors and suppliers.



<PAGE>



PART II. OTHER INFORMATION

Item 1.  Legal Proceedings.  Not applicable.

Item 2.  Changes in Securities.


         On December  31,  1997,  the Company  issued  5,000  shares of Series A
         Convertible  Preferred,  $0.10 par  value,  and  warrants  to  purchase
         150,000  shares of  Common  Stock,  exercisable  at $7.95 per share and
         expiring on December 31, 2001, to RGC International Investors, LDC, for
         an  aggregate  purchase  price of $5 million.  The sale of the Series A
         Convertible  Preferred  and the  warrants  was  arranged  by  Shoreline
         Pacific Institutional  Finance, the Institutional Division of Financial
         West Group,  which received a fee of $250,000 plus warrants to purchase
         20,000  shares of Common  Stock,  exercisable  at $6.625  per share and
         expiring  on  December  31,  2000.  (See  Note 3 of Notes to  Condensed
         Consolidated Financial Statements).

         During the quarter ended  December 31, 1997,  the Company issued 48,780
         shares of Common  Stock  pursuant  to the  conversion  of  $200,000  of
         convertible  debt by a single holder of the  Company's 10%  convertible
         subordinated  notes due  October  31,  1999.  These  10%  notes  have a
         conversion price of $4.10 per share.  Additionally,  the Company issued
         1,120 shares of Common Stock  pursuant to the  conversion  of $7,560 of
         convertible  debt by a single  holder of the  Company's 9%  convertible
         subordinated  notes  due  September  15,  2000.  These 9% notes  have a
         conversion price of $6.75 per share.  These shares were issued pursuant
         to an exemption under Section 3(a)(9) of the Securities Act.

         During the quarter  ended  December  31,  1997,  the  Company  issued a
         combined  total of  64,000  shares of  Common  Stock to three  separate
         warrant holders,  upon the exercise of outstanding  warrants  (exercise
         price of $1.75 per  share).  These  shares  were  issued in a nonpublic
         offering  pursuant to transactions  exempt under Section 3(a)(9) of the
         Securities Act of 1933, as amended.

         On January 2, 1998, the Company issued  $1,443,750  principal amount of
         its 5% Convertible  Subordinated Debentures due September 30, 2002 to a
         single  investor in exchange for cash and the assignment to the Company
         of certain equipment leases. The Debentures were issued without the use
         of underwriters in a transaction exempt from registration under Section
         4(2) of the Securities Act of 1933, as amended.  The investor  acquired
         the securities for investment and without a view to  distribution.  The
         debentures are convertible  into Common Stock of the Company,  at $8.25
         per share, after December 31, 1998.

         During  the  quarter  ended  March 31,  1998,  the  Company  declared a
         dividend  on its  outstanding  Series A  Convertible  Preferred  Stock,
         payable  on March 31,  1998 to  stockholders  of record at the close of
         business on March 27, 1998.  The  dividend,  payable at the rate of 5%,
         was paid at the Company's option in the form of 62.5 additional  shares
         of the Company's  Series A Convertible  Preferred  Stock (See Note 3 of
         Notes to Condensed Consolidated Financial Statements).

         During the quarter ended March 31, 1998,  the Company issued 373 shares
         of Common Stock  pursuant to the  conversion  of $2,520 of  convertible
         debt by a single  holder of the Company's 9%  convertible  subordinated
         notes due September 15, 2000. These 9% notes have a conversion price of
         $6.75 per share.  These  shares  were issued  pursuant to an  exemption
         under Section 3(a)(9) of the Securities Act.

         Also during the  quarter  ended March 31,  1998,  the Company  issued a
         combined  total of  30,000  shares  of  Common  Stock to four  separate
         warrant holders,  upon the exercise of outstanding  warrants  (exercise
         price of $1.75 per  share).  These  shares  were  issued in a nonpublic
         offering  pursuant to transactions  exempt under Section 3(a)(9) of the
         Securities Act of 1933, as amended.

         On  May  28,  1998,  the  Company  issued  9,000  shares  of  Series  B
         Convertible  Preferred,  $0.10 par  value,  and  warrants  to  purchase
         180,000  shares of Common  Stock,  exercisable  at $13.75 per share and
         expiring on May 28,  2002,  to RGC  International  Investors,  LDC, and
         1,000 shares of Series B Convertible  Preferred,  $0.10 par value,  and
         warrants to purchase  20,000  shares of Common  Stock,  exercisable  at
         $13.75 per share and expiring on May 28, 2002, to Shoreline  Associates
         I, LLC for an aggregate purchase price of $10 million.  The sale of the
         Series  B  Convertible  Preferred  and the  warrants  was  arranged  by
         Shoreline Pacific Institutional  Finance, the Institutional Division of
         Financial West Group, which received a fee of $500,000 plus warrants to
         purchase 50,000 shares of Common Stock, exercisable at $11.00 per share
         and  expiring  on May 28,  2002.  (See  Note 3 of  Notes  to  Condensed
         Consolidated Financial Statements).

         During the quarter ended June 30, 1998,  the Company  issued a combined
         total of 299,946 shares of Common Stock,  pursuant to the conversion of
         2,000  shares  of  the  Company's   outstanding  Series  A  Convertible
         Preferred.  The  Series  A  Convertible  Preferred,  including  accrued
         dividends,  was converted into common shares at the conversion price of
         $6.69 per share.  These  shares  were issued  pursuant to an  exemption
         under Section 3(a)(9) of the Securities Act.

         In addition, during the quarter ended June 30, 1998, the Company issued
         a combined  total of 120,148  shares of Common  Stock  pursuant  to the
         conversion of $811,000 of convertible  debt by two separate  holders of
         the Company's 9% convertible subordinated notes due September 15, 2000.
         These 9% notes have a conversion price of $6.75 per share. In addition,
         the Company issued 5,000 shares of Common Stock to the single holder of
         the Company's 9% convertible  subordinated notes due December 31, 1998,
         pursuant to the conversion of the remaining $25,000 of this convertible
         debt. These 9% notes had a conversion  price of $5.00 per share.  These
         shares were issued  pursuant to an exemption  under Section  3(a)(9) of
         the Securities Act.

         Also  during the quarter  ended June 30,  1998,  the  Company  issued a
         combined  total of  317,937  shares  of Common  Stock to nine  separate
         warrant holders,  upon the exercise of outstanding  warrants  (exercise
         prices ranging from $1.75 - $7.875 per share). These shares were issued
         in a nonpublic  offering pursuant to transactions  exempt under Section
         3(a)(9) of the  Securities Act of 1933, as amended.  Additionally,  the
         Company  issued a combined  total of 111,943  shares of Common Stock to
         five separate  individuals,  upon the exercise of outstanding  employee
         stock options (exercise price of $4.94 per share).

Item 3.  Defaults upon Senior Securities.  Not applicable.

Item 4.  Submission of Matters to a Vote of Security Holders.  Not applicable.

Item 5.  Other Information.

         On June 19, 1998, the Company filed a Form S-3  Registration  Statement
         under  the  Securities  Act of 1933  registering  the  resale  of up to
         2,495,309  shares of the Company's Common Stock,  previously  issued or
         issuable upon the exercise of outstanding stock purchase warrants,  the
         conversion of the Company's 5% Convertible  Subordinated  Debenture due
         September  30,  2002  and the  conversion  of the  Company's  Series  B
         Convertible   Preferred  Stock  (See  Note  3  of  Notes  to  Condensed
         Consolidated  Financial  Statements).  This  registration  was declared
         effective on July 31, 1998.

Item 6.  Exhibits and Reports on Form 8-K.

     (a) Exhibits

         Exhibit  10.1  -  Letter  confirming  employment  of  Dr.  Lawrence  B.
                           Brilliant, dated April 7, 1998

         Exhibit 27     -  Financial Data Schedule

     (b) Reports on Form 8-K

         On  April  24,  1998,  the  Company  filed  a Form  8-K  reporting  the
         resignation  of  Mr.  A.J.R.  Oosthuizen  as  President,  CEO  and as a
         Director of the Company, effective as of April 4, 1998.

         On June 1, 1998, the Company filed a Form 8-K reporting the designation
         and issuance of 10,000 shares of Series B Convertible  Preferred  Stock
         (See Note 3 of Notes to Condensed Consolidated Financial Statements).

         On July 28,  1998,  the  Company  filed a Form 8-K  reporting  both the
         adoption  of a Cable  Affiliates  Incentive  Program  and the  Board of
         Director's  decision  to account for the  Company's  Telecommunications
         Division as a discontinued operation.




<PAGE>




                                   SIGNATURES



In accordance with the requirements of the Securities  Exchange Act of 1934, the
Registrant  has duly  caused  this  report  to be  signed  on its  behalf by the
undersigned, thereunto duly authorized.

                                             SOFTNET SYSTEMS, INC.



                                             /s/ Garrett J. Girvan
                                             -------------------------------
                                             Garrett J. Girvan
                                             Chief Operating Officer and
                                                     Chief Financial Officer


                                             /s/ Mark A. Phillips
                                             -------------------------------
                                             Mark A. Phillips
                                             Principal Accounting Officer


Dated:  August 14, 1998